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For homeowners age 62 and older, the federally insured Home Equity Conversion Mortgage (HECM) is the most common reverse mortgage product. Over the last 15 years, the HECM has undergone significant changes, becoming a popular tool for retirees seeking assistance with cash flow, liquidity, tax planning, and even enhancing their net worth. However, the greatest potential impact of a HECM right now might be debt consolidation.
Debt consolidation is a financial strategy that combines multiple debts into a single loan, often with better terms like lower interest rates or lower payments. This can make debt management easier, reduce the risk of default, and ultimately save the borrower money.
HECM Debt Consolidation, which I’ll call HDC, uses a reverse mortgage to leverage housing wealth to pay off existing mortgages, liens against the property, installment debt such as car loans, and revolving consumer debt like credit cards. You can consolidate all these debts into a single loan without a required monthly principal and interest mortgage payment. Simply occupy the house and pay all property-related charges, such as taxes and insurance. The amount that is drawn, plus interest, is generally paid off when the home sells in the future.
Note that the HECM is NOT able to directly pay off consumer debt unrelated to the home. Rather, the HECM provides the cash proceeds for those payoffs. Other reverse mortgage products known as “proprietary reverse mortgages” may pay the debts directly when the loan funds.
THE TIME IS NOW!
Today’s consumers are taking on too much debt and not saving enough. Over the last 10 years, consumer revolving debt has increased by over 77%, while the personal savings rate has decreased by over 44%. During the Federal stimulus response to COVID-19, consumer debt actually decreased, and personal savings rates increased. However, that debt relief was temporary.
The good news for older homeowners is that home values have appreciated an average of 106% over the last 10 years. So, there has never been a better time for an HDC.
BASELESS CONCERNS
The conventional wisdom is that this strategy increases the risk of foreclosure. Even the Consumer Financial Protection Bureau (CFPB) discourages reverse mortgages for this very reason. However, the agency doesn’t understand there is actually a clear reduction in the risk of foreclosure.
With traditional mortgages, the primary reason for home foreclosures is failure to pay the mortgage payment. But remember, reverse mortgages do not require monthly principal or interest payments. Furthermore, the elimination of consumer debt makes it easier to pay critical payments like property taxes.
Dave Ramsey followers steer clear of this strategy because they view mortgages as debt instruments and believe that “all debt is bad.” However, the math is clear: the Ramsey “debt snowball” process is terribly inefficient when paying revolving debt interest rates of 20–30% while simultaneously making a required monthly mortgage payment. In as little as 30 days, a properly trained mortgage professional could help a client complete Dave Ramsey’s first five “Baby Steps” which often takes Ramsey followers years to complete).
WHY NOT CASH-OUT REFINANCE?
Traditional (forward) debt consolidation loans may not work in today’s higher interest rate environment. It may be risky to double a homeowner’s mortgage rate to pay off revolving debt, such as credit cards. Even if the weighted average interest rate decreases, this might not make sense because it increases the monthly mortgage payment. And, of course, non-payment of a mortgage generally results in foreclosure.
THE HDC SOLUTION
Homeowners who implement an HDC strategy are thrilled to have a mortgage without a monthly bill. If, however, the homeowner is concerned about interest accruals on their monthly statement, they have every right to make optional payments whenever they wish. The HECM product offers an advantage in that voluntary payments not only lower the loan balance but also expand the available credit line for future use.
To prevent consumer debt from accumulating again, an HDC requires discipline and a solid plan. However, today’s reverse mortgages can be used for a wide spectrum of financial planning purposes, like tax strategies, ROTH conversions, Social Security filing decisions, long-term care planning, portfolio optimization, and yes, debt consolidation.